Damodaran on Valuation_ Security Analysis for Investment and Corporate Finance ( PDFDrive )

dividends),theexpectedreturnonequity(whichdetermines
theexpectedgrowthrate),andthebeta(whichaffectsthecost
ofequity).InIllustration4.1,wearguedthatGoldmanSachs
would havea five-year high-growth period. Thefollowing
tablesummarizestheinputsintothedividenddiscountmodel
for the valuation of Goldman Sachs.

High-Growth

Period

Stable-Growth

Period

Payout ratio 9.07% 66.67%

Return on equity 18.49% 12.00%

Expected growth rate 16.82% 4.00%

Beta 1.20 1.00

Costofequity(risk-freerate=

4.5%; risk premium = 4%)

9.30% 8.50%

Notethatthepayoutratioandthebetaforthehigh-growth
periodarebasedonthecurrentyear’svalues.Thereturnon
equityforthenextfiveyearsissetat18.49%,whichisthe
currentreturnonequity.Theexpectedgrowthrateof16.82%
forthenextfiveyearsistheproductofthereturnonequity
andtheretentionratio.Instablegrowth,weadjustthebetato
1,loweringthecost ofequityto8.5%.Weassumethatthe
stablegrowthratewillbe4%,justslightlybelowthenominal
growthrateintheeconomy(andtherisk-freerateof4.5%).
Wealsoassumethatthereturnonequitywilldropto12%,
stillabovethecostofequityinstablegrowthbutreflecting
Goldman’ssubstantialcompetitiveadvantages.Theretention
ratio decreases to 33.33%, as both growth and ROE drop.